Tax TrapsWhat is your AUDIT RISK?

Millionaires get the most exam scrutiny. Last year the IRS audited one out of every nine returns with incomes of $1 million or more. And those with income between $200,000 and $1,000,000 also felt heat. 3% were audited in person or by correspondence.

Are you waving a RED FLAG?

Claiming 100% business use of a vehicle? This is red meat for IRS agents. They know that it’s extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.

Deducting business meals, travel and entertainment on your schedule C? Big deductions here are always ripe for audit. A large write-off will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation requirements.

Writing off a hobby loss? Your chances of losing the audit lottery increase. If you have wage income and file a Schedule C with large losses. And if the activity sounds like a hobby…dog breeding, car racing and such…IRS’ antennas go up higher.

Deducting rental losses? The IRS is actively scrutinizing rental real estate losses, especially those written off by taxpayers who claim to be real estate professionals and whose W-2 forms or other non-real-estate businesses show lots of income. Agents want to see records that these folks spent over 50% of their working hours and at least 750 hours each year materially participating in real estate activities.

Running a small business. Owners of cash-intensive small firms…taxis, hair salons, car washes and such…are a tempting audit target. The Service knows that those who receive mainly cash are less likely to accurately report all their income.

Failing to report a foreign bank account. The agency is intensely interested in people with offshore accounts. This would include having signature authority on someone else’s account in a foreign country. Tax authorities have had success in getting foreign banks to disclose account owner information. This is a top IRS priority. Keeping mum about the accounts can lead to harsh fines.

Tax Tips

A reminder to filers with a home office. You have a simpler write-off option for 2013. You can avoid allocating actual costs and figuring depreciation. The IRS now allows you to deduct $5 per square foot of space used exclusively for business - up to 300 square feet. The maximum write-off using this method is $1,500 even if you run more than one business from home and use more than 300 square feet.But the really good news is that Itemizers using this simplified method can claim all of their allowable mortgage interest and real estate taxes on Schedule A without a reduction for business use.

Maximize your retirement contributions – don’t rely on the government for your retirement. The 401(k) limit remains $17,500 in 2014. If you were born before 1965 can put in an extra $5,500. Ditto for 403(b) and 457 plans. The ceiling on SIMPLEs stays $12,000...$14,500 for taxpayers age 50 or older this year. Contribution caps for IRAs and Roths remain $5,500 plus $1,000 more for anyone 50 and up.

IRS eases the rules for maintenance and supply expenses. Businesses may be able to deduct (rather than depreciate) expenses up to $500 per item in 2014. This “safe harbor” is available if a written policy is established at the beginning of the year.

Student loan interest paid by Mom and Dad. In the past, if parents paid back a student loan incurred by their children, no one got a tax break. To get a deduction, the law said that you had to be both liable for the debt and actually pay it yourself. But now there’s an exception. If Mom and Dad pay back the loan, the IRS treats it as though they gave the money to their child, who then paid the debt. So a child who’s not claimed as a dependent can qualify to deduct up to $2,500 of student loan interest paid a parent.

Moving expense. Here’s an interesting dichotomy: Job-hunting expenses incurred while looking for your first job are not deductible, Nor is training for a new profession, but moving expenses to get to a new job may be deductible. And you get this write-off even if you don’t itemize. If you moved more than 50 miles, you may be able to deduct the cost of move yourself and your household goods to the new area.

Don’t miss the additional child care credit. A tax credit is so much better than a deduction—it reduces your tax bill dollar for dollar. The IRS allows you to have up to $5,000 of daycare expenses paid through a tax-favored reimbursement account at work. Now, however, up to $6,000 can qualify for the credit, but the old $5,000 limit still applies to reimbursement accounts. So if you run the maximum $5,000 through a plan at work but spend more for work-related child care, you can claim the credit on up to an extra $1,000. That would cut your tax bill by at least $200.